UAE: Double-digit growth seen in 2005

2004 as good as it gets, but not for UAE

For the world economy, 2004 was as good as it gets. Global growth soared while interest rates remained incredibly low. Clearly this was not sustainable.

The only blot on the global landscape in 2004 was high oil prices. This problem has increasingly come into focus in 2005 as oil prices tested USD 70 per barrel in August. Of course, for the Middle East, higher oil prices are a boon to economic activity both directly and indirectly.

Directly they boost nominal economic activity as countries receive more for their energy exports. In real terms, they benefit to the extent that oil production volumes rise in the face of strong demand and that governments use higher fiscal revenues to push for further structural diversification. The United Arab Emirates (UAE) is benefiting on all three fronts.

Three factors to push growth to 10%

Let's go through each of the above three factors in turn. First, we expect the UAE's average oil price to rise around 35% in 2005, with recent oil price moves placing this slightly on the conservative side.

In 2004, oil production accounted for almost a third of overall economic activity. Therefore, higher oil prices alone should contribute 11-12% to nominal GDP growth in 2005.

Second, on the production side, Abu Dhabi - which has 94% of the country's oil reserves - is working hard to expand oil capacity. While the impact on production is only likely to be felt in 2006, the investment in this capacity is already boosting economic activity.

The final area, which has really taken off in recent times, is government efforts to use the fiscal revenue windfall (the budget surplus is expected to be around 20% of GDP this year) to provide alternative growth drivers for the country.

Given its rapidly reducing oil reserves, Dubai has led the way in this regard. But other emirates are following suit with Abu Dhabi pushing ahead with utility privatisation and reportedly considering relaxing controls over the real estate market.

All these efforts have resulted in the UAE winning plaudits for being the region's most competitive economy and having the least onerous administrative regulations. This means that the country remains a favoured destination for those looking to benefit from the region's boom.

In 2004, this led to almost a 9% expansion in the UAE's non-hydrocarbon sector and the signs are that this may accelerate further in 2005. So what does this mean for our forecasts?

Well it appears our previous forecast for 8% growth this year looks on the conservative side. Indeed, looking over recent years, the fundamentals look almost as strong as in 2003 when the economy expanded 11.6%. Therefore, we are revising up our growth forecast for 2005 to 10% with upside risks.

For 2006, while oil prices are expected to decline from their recent highs, they are meant to remain reasonably high, still creating significant fiscal latitude for the authorities to support the economy. Meanwhile, increased oil production is expected to be a boon for real growth.

This should be more supportive of economic activity than previously anticipated and thus we are also revising our 2006 growth forecast higher to 7%.

Inflationary pressures also rising

Meanwhile, we expect inflationary pressures to accelerate in the near-term, with rising rents a major contributing factor to this acceleration. After 4.6% inflation last year, we expect inflation to accelerate to 6.5% in 2005.

The recent 31.5% increase in petrol prices reinforces this upward bias for inflationary pressures going forward with taxi drivers already indicating they should be allowed to pass on this cost increase to passengers.

For 2006, we expect inflation to slow back to 5%, although this is premised on the assumption that rent price accretion will slow somewhat next year as new projects are completed and the supply of properties at least matches the increase in demand.

However, one aspect that has supported property prices this year has been the delays in the completion of projects and the risk is that this continues into 2006.

Key challenge is to retain cost competitiveness

Looking over a longer time period, the key challenge for the UAE is to translate these strong fiscal surpluses into a sustained strong economic performance, even in the event that oil prices slump.

In this regard, the need to retain cost competitiveness is a key issue. But for this to be addressed, the current housing boom must come to an end in the not-too-distant future. Hopefully, the new supply of housing will deflate the property and equity market bubbles, rather than bursting them.